Glossary term
Transition Risk
Subject: Sustainability and ESG, Climate Risk
Also known as: Climate transition risk, Low-carbon transition risk
Transition risk is the risk of financial loss arising from the shift to a low-carbon economy, through changes in policy, technology, market demand, legal liability and reputation.
Explanation
The risk builds as the world responds to climate change. Policy and legal risks include carbon prices, emissions limits, disclosure rules and lawsuits. Technology risk arises when cleaner alternatives, such as electric vehicles, replace established products. Market risk follows changes in customer preference and the cost of inputs. Reputation risk follows when stakeholders turn against high emitters. Heavy emitters such as power, steel, cement, oil and aviation are most exposed, but lenders and insurers are affected through their clients. The size of the effect depends heavily on how fast and how orderly the shift is, so firms examine it with scenarios. It can also bring opportunity for those who supply low-carbon products. A sudden policy shift can reprice assets and strand investments within a few years.
Example
A regional steel producer runs coal-based blast furnaces. A new carbon price and customer demand for low-carbon steel threaten its margins. Its lenders rate it high for transition risk, ask for a decarbonisation plan and cap their exposure to the sector.
Not to be confused with
- Physical Climate Risk
- Transition risk comes from the move away from fossil fuels. Physical risk comes from climate hazards themselves.